ORDER
R.P. Garg, Vice President
1. These cross appeals are against the orders of Commissioner of Income-tax (Appeals) for assessment years 1992-93 and 1993-94. for the sake of convenience, they are being disposed of by this common order.
2. In the Revenue’s appeals for both the years, the dispute is for deleting the addition made by the Assessing Officer on account of retention money of 10% claimed by the assessee to be not taxable amounting to Rs. 1,58,70,856 and Rs. 36,68,397 respectively.
3. The assessee is engaged in the business of civil construction of Sardar Sarovar Dam, railway and structural work, etc. The assessee raised the bills as per completion of work and show the billed amount as receipt and the amount incurred in carrying out the job as expenditure. In the return, however, the assessee claimed that as per the terms of the contract the money was withheld by the government pending verification of satisfactory completion of the work for which the payment related; the said retention money did not arise or accrue nor any right accrued or arisen to receive until the satisfactory completion of the work or removal of the defect and payment of damages, if any. Reliance was placed on the decision of Calcutta High Court in the case of Simplex Concrete Piles (India) Pvt. Ltd. 45 Taxman 370 (Cal.) and in the case of M/s. Shoorji Vallabhdas and Co. 46 ITR 144.
4. The AO did not accept the assessee’s claim. He held that in Simplex Concrete Piles (India) Pvt. Ltd. (supra) net of retention money was credited and debited in the profit and loss account whereas in the assessee’s case the gross contractual receipts were credited though the assessee claimed the debit in the return of income of the amount retained. Shoorji’s case (supra) talked about the nature of income and it held that hypothetical income cannot be taxed and retention money is not hypothetical income and only the point of time of taxability was attached. He further held that 10% deduction was as security performance and was immediately released to the assessee on submission of bank guarantee. Infact, the assessee was permitted to get its security deposit in the nature of retention money to convert it into interest bearing security/deposit or else to submit bank guarantee or performance bond in lieu of retention money released, which was retainable after the defect, liability period was over. The assessee thus got the gross amount of the receipt on submission of bank guarantee. He observed that out of the retention money of Rs. 1,58,70,856/- in asst. year 1992-93 a sum of Rs. 1,49,02,778/- pertained to Narmada Main Canal Project and in Clause 5 of their agreement there is no mention of retention money and it speaks of security performance whereunder a sum of Rs. 22 million is the security to be furnished by the assessee for Rs. 132 million project for the package or Rs. 66 million for the slice Member or from a bonding company and in addition 10% as additional security subject to an overall limit of 7.5% of the tender amount which was subject to and actually released on submission of bank guarantee. It was thus not a retention money, but additional security of the nature of initial security. The whole of the amount was not contingent only to remove the defects but also for overall performance of the contract. It, therefore, accrued to the assessee and was actually received. he also observed that upto asst. year 1991-92 the said amount was being offered as income by the assessee itself and no claim for deduction was made if it was allowed it would give incorrect working of the profit as there are instances where the earlier retention money was released in this year and furthermore all the expenditure related to this receipt have been debited in the current year.
5. The CIT(A) deleted the addition by observing on pages 10 to 13 as under:-
“C. I have considered the facts and the appellant’s submissions. The relevant fact to be considered is whether or not the right to receive the retention money accrued to the appellant on the submission of the bills in the previous year relevant to the assessment year under consideration. In CIT v. Gajapathy Naidu (53 ITR 114), the Supreme Court examined the question as to when the income accrues and laid down that when the assessing officer proceeds to tax a particular income, he should ask himself, inter alia, two questions, viz. (i) what is the system of accountancy adopted by the assessee and (ii) if it is the mercantile system of accountancy, when has the right to receive the particular income accrued. From the facts of the appellant’s case discussed in detail supra, it is clear that right to receive the retention money has not accrued to the assessee in the previous year relevant to the assessment year under consideration. As discussed above, right to receive retention money accrues to the appellant only after the satisfactory completion of the contract and after the defect liability period is over and after engineer-in-charge has certified that no liability attaches to the appellant. However, as discussed above, it is the appellant’s contention inter alia that the relevant works are still not completed, and that the right to receive retention money has not accrued so far.
It is also relevant to note that in its judgment reported as CIT v. Simplex Concrete Piles (India) Pvt. Ltd. (179 ITR 8), Calcutta High Court had referred to the Supreme Court’s judgment reported as 53 ITR 114, and had held that having regard to the terms and conditions of the contract, it could not be held that the retention money became legally due to the assessee on the completion of the work. Only after the assessee fulfilled the obligations under the contract, the retention money would be released and the assessee would acquire the right to receive such retention money. Therefore, on the date when the bills were submitted, no enforceable right accrued or arose and, accordingly, it could not be said that the assessee had any right to receive the entire amount on the completion of the work or on the submission of bills. The assessee had no right to claim any part of the retention money till the verification of satisfactory execution of the contract. Therefore, Calcutta High Court held that the Tribunal was right in holding that the retention money in respect of the job completed by the assessee during the relevant previous year should not be taken into account in computing the profit of the assessee for the assessment year in question.
Similarly, on similar facts, in CIT v. Chanchani Brothers (Contractors) Pvt. Ltd. (161 ITR 418), Patna High Court has held that though under the mercantile system of accounting all terms of credit are brought into credit immediately they become legally due and before they are actually received, and all expenditure is debited for which a legal liability has been incurred before it is actually disbursed, yet before a credit or debit entry can legitimately be made in the accounts, it must be shown that a certain enforceable liability has accrued or arisen and that such liability must be one that has been ascertained and capable of being enforced by the person in whose favour the debit has been raised.
Mention may also be made of Janatha Contract Co. v. CIT (105 ITR 625) wherein Kerala High Court has held that when there is a stipulation postponing the time for payment of the whole or part of the balance, until after the expiration of a period during which the contract is liable for defects or for repairs, payment would not have become due to that contractor.
Considering the facts and appellant’s submissions discussed in detail above, and also considering the terms of the contracts stipulated in General Conditions of Contract, it is held that the ratio of the judgments reported as CIT v. Simplex Concrete Piles (India) Pvt. Ltd. 179 ITR 8 (Calcutta), CIT v. Chanchani Bros. (Contractors) Pvt. Ltd. 161 ITR 418 (Patna) and Janatha Contract Co. v. CIT 105 ITR 627 (Kerala) is directly applicable to the appellant’s case. Therefore, considering the totality of the facts and appellant’s submissions discussed above, and following the principles laid down in the judgments reported as 53 ITR 114 (Supreme Court), 179 ITR 8 (Calcutta), 161 ITR 418 (Patna) and 105 ITR 627 (Kerala), it is held that the income represented by retention money has not accrued in the previous year in which the running account bills have been submitted, but the said income accrues only after the completion of the contract and after the defect liability period is over and after engineer-in-charge has certified that no liability attached to the appellant. Accordingly, it is held that the said amount of retention money is not taxable in the assessment year under consideration, but is taxable in the assessment year relevant to the previous year in which the work is completed and relevant conditions of the Contracts are fulfilled. Accordingly, it is held that the assessing officer has wrongly rejected the appellant’s claim for deduction of retention money for the assessment year under consideration. Therefore, the assessing officer is directed to allow the appellant’s claim for retention money of Rs. 1,58,70,856/- for the assessment year under consideration. Therefore, the appellant gets a relief of Rs. 1,58,70,856/- for the assessment year under consideration i.e. 1992-93. However, the assessing officer is directed to tax the said retention money in the assessment year relevant to the ‘previous year’ in which retention money becomes payable to the appellant as per the terms of the contract i.e. after the defect liability period is over and after the engineer-in-charge certifies that no liability attaches to the appellant.”
6. The learned Department Representative Shri R.C. Gupta contended that the CIT(A) has not considered the case made out by the AO namely that amount was actually received; that the retention money was only a security deposit and that the expenses have been debited in full. He referred to Clauses 5.1, 5.3 and 5.4 of the agreement and filed the copy of the account of the assessee wherein transactions are recorded. He then referred to the Tribunal decision in the case of Dhorajia Construction Co. ITA No. 4327 and 4665. Ahd. 1996 dated 29-8-2002 for asst. year 1993-94. He also submitted that tax has been deducted at source on the entire amount and auditors have approved the accounts maintained by the assessee.
7. The ld. counsel of the assessee Shri K.C. Patel submitted that it is a case of retention money deducted from the running bills at the rate of 10%. Initial security deposit of Rs. 2,56,63,000/- was separately given by the assessee. It was actually received and offered to tax in the revised return for asst. year 2000-01 as the defect liability expired in that year with the following note:
“1. Our company is engaged in the business of construction of civil works, dams, canals, roads, etc. During the year relevant to A.Y. 92-93 our company executed the work of Narmada Main Canal for and on behalf of the Government of Gujarat. From the total receipts during the year relevant to A.Y. 92-93, for the work of Narmada Main Canal, the Government of Gujarat, as per the terms of contract, had retained an amount of Rs. 1,49,02,778/-.
As per the terms of contract, the money was withheld by the Government pending verification of the satisfactory completion of work. The amount retained was receivable by the company after the defect liability period was over. Since no right accrued or arose to receive the amount so retained the company had claimed deduction of security deposit of Rs. 1,49,02,778/- from the total income for A.Y. 92-93. The learned assessing officer rejected our claim for deduction. In appeal the learned CIT(A) allowed our claim of deduction for security deposit.
As per the terms of contract the defects liability period was fixed as the period of twelve months commencing from the day following the date of completion of work. The defects liability period expired during financial year 1999-2000 relevant to A.Y. 2000-01 as per the terms of the contract. The amount of security deposit therefore accrued and was receivable by the company during the F.Y. 1999-2000. The return of A.Y. 2000-01 is therefore revised to include the security deposit of Rs. 1,49,02,778.”
8. Besides the cases relied upon and referred to by the CIT(A) he also relied upon the decision of the Supreme Court in the case of CIT v. Hindustan Housing and Land Development Trust Ltd. 161 ITR 524 and submitted that a receipt on bank guarantee is not income. He also submitted that the case of Dhorajia Construction Co. was a case of security deposit and not of retention money. He also relied upon the decision of Gujarat High Court in the case of Anup Engineering Ltd. 247 ITR 457 and in the case of Western India Engineering Co. 81 ITR 712, the decision of Patna High Court in the case of Chanchani Brothers (Contractors) Pvt. Ltd. 161 ITR 418 and Kerala High Court in the case of Janatha Contract Co. 105 ITR 627. He also referred to the Tribunal decision in the case of Kevin Enterprise ITA No. 1234/Ahd/1999 dated 12-4-2000, R.B. Construction ITA No. 3018 and 4186/Ahd/1995 dated 7-12-2001 and in the case of Apollo Industries ITA No. 3998/Ahd/1992 dated 16-6-2000. With regard to the general concept of accrual of income/real income he referred to the decisions of (i) E.D. Sassoon & Co. Ltd. and Ors. 26 ITR 27 (SC); (ii) Shoorji Vallabhdas and Co. 46 ITR 144 (SC); (iii) A. Gajapathy Naidu 53 ITR 114 (SC); (iv) Bokaro Steel Ltd. 236 ITR 315 (SC); (v) Kedarnath Jute Mfg. Co. Ltd. 82 ITR 363 (SC); (vi) Core Healthcare Ltd. 251 ITR 61 (Guj.); and (vii) Hindustan Housing And Land Development Trust Ltd. 161 ITR 524 (SC).
9. We have heard the parties and considered the rival submissions. As per Clause 2 of Section 1 of the “international Competitive Bidding Information and Instruction for Tenderers”, the tender was to be bid for the construction of Narmada Main Canal in the reach of Kms. 108 to 144 for excavation, embankment, filters, concrete lining, drainage arrangement and structures divided into two slices. The tender was to be submitted with earnest money deposit as per Clause 10 as under:-
“10.1 Earnest Money Deposit of Rs. 8.50 million or equivalent amount in U.S. Dollars or Pound Sterling must accompany the tender for the package. For the tenderers for slices the Earnest Money Deposit shall be Rs. 4.30 million or equivalent amount in U.S. Dollars or Pound Sterling for each slice for which the bidder is qualified. If the tenderer qualified for package or more slices desires to bid for less number of slices the Earnest Money Deposit shall relate to such number of slices. This deposit will be in favour of the Executive Engineer, Narmada Project Main Canal Construction Division No. 11, Ahmedabad, C-3, Narmada Vasahat, Gandhinagar-Sarkhej Highway, Ahmedabad-380051, Gujarat State (India) and may be in the form of :
(i) Bank draft or certified cheque or irrevocable letter of credit amounting to Rs. 8.50 million for package & Rs. 4.30 million for each slice of any Schedule Indian Bank or a Foreign Bank approved by the Reserve Bank of India.
Or
(ii) Bank guarantee for Rs. 8.50 million for package & Rs. 4.30 million for each slice in the form prescribed in Annexure-4 from a Schedule Indian Bank or a Foreign Bank approved by the Reserve Bank of India.
Or
(iii) In the shape of a Bid Bond in the form prescribed in Annexure-5 from a company accepted to the SSNL and confirmed by any schedule Indian Bank.
In the case of a Joint Venture, the Earnest Money Deposit will be accepted only from the Joint Venture or from one of the parties on behalf of that Joint Venture.”
10. This tender money was to be returned on furnishing of security deposit for performance. Clause 10.4 and Clause 10.5 dealing with this read as under:
“10.4 The Earnest Money Deposit will be returned promptly to the unsuccessful tenderers. The Earnest Money Deposit will be returned to the successful tenderer after he furnishes security deposit for performance and duly enters into the contract. (underlined by us)
10.5. Within thirty days from the date of receipt of the letter accepting his tender, the successful tenderer shall furnish the required security for performance and attend the office of the Engineer-in-Charge for execution of the Contract documents. If he fails to furnish the security for performance or to execute the Contract, his Earnest Money Deposit shall be forfeited and the tenderer may be disqualified from tendering for further works in the State of Gujarat (India).”
11. Clause 5 of the general conditions of the contract provides for the manner of aforesaid security of performance with which we are concerned in this case as under:-
“5.1 Within thirty days from the date of issue of the letter accepting his tender, the Contractor shall furnish an initial security deposit in the denominations and proportions of the currencies of payments required as per Clause II-11.2 in the form of
(a) Bank Guarantee for Rupees 22.0 million for the package or Rupees 11 million for Slice Number I or II in the form in Annexure 6 from a Scheduled Indian Bank or a Foreign Bank approved by the Reserve Bank of India;
(b) A performance bond for Rupees 132 million for the package or Rupees 66 million for Slice Number I or II from a bonding company in the form in Annexure 7 confirmed by any Scheduled Indian Bank and accepted to the SSNL.
5.2 The Cross Selling Exchange rates between the Pound Sterling and Rupees as established by Reserve Bank of India and London Bank Clearing Selling rate between the Pound Sterling and the currency of the Bank Guarantee/Performance Bond on the date of issue, be used to determine its Rupee value.
5.3 In addition to the above initial security deposit, the Engineer-in-charge shall deduct from the intermediate bills i.e. the running account bills an amount at the rate ten percent (10%) of the total value of each bills as an additional security deposit subject to the condition that the total amount of such deductions shall not exceed seven and one half percent (7.5%) of the tendered amount as mentioned in the letter of acceptance of the tender.
5.4 If the Contractor expressly requests in writing, he will be permitted to convert quarterly, Security Deposit recovered from his bills into interest-bearing SSNL Securities or interest-bearing deposits with a Scheduled Indian Bank in the name of Executive Engineer, Narmada Project Main Canal Construction Division No. 11, Ahmedabad – 380051, Gujarat State (India).
5.5 The Bank guarantee, the performance bond, the interest bearing SSNNL Securities and the interest-bearing SSNNL Securities and the interest-bearing deposits shall remain valid for at least twelve months after the date of the completion of the works.
5.6 The security deposit, less any amounts due, shall be returned to the Contractor after the defects liability period is over and subject to the Engineer-in-Charge certifying that no liability attaches to the Contractor.
12. The said Clauses 5.1, 5.3 and 5.4 were amended subsequently as under:-
“5.1 Within thirty days from the date of issue of the letter accepting his tender, the contractor shall furnish an initial security deposit in the denominations and proportions of the currencies of payments required as per Clause II-11.2 in the form of
(a) Bank Guarantee for five percent of the tendered amount mentioned in the letter of acceptance of the tender in the form in Annexure 6 from a Vadodara branch of Scheduled Indian Bank or from a Foreign Bank acceptable to SSNNL and confirmed by any Scheduled Indian Bank authorised to deal in foreign exchange;
or
(b) A performance bond for thirty percent of the tendered amount mentioned in the letter of acceptance of the tender in the form in Annexure 7 from a bonding company acceptable to the SSNNL
5.3 In addition to the above initial security deposit, the Engineer-in-charge shall deduct from the intermediate bills i.e. the running account bills an amount at the rate ten percent (10%) of the total value of each bills as an additional security deposit subject to the condition that the total amount of such deductions shall not exceed five percent (5%) of the tendered amount as mentioned in the letter of acceptance of the tender. (underlined by us)
5.4 “If the Countractor expressly requests in writing, he will be permitted to convert Security Deposit recovered from his bills into interest bearing Government/SSNNL Securities or interest-bearing deposits with a Scheduled Indian Bank taken out in the name of Engineer-in-charge or into Bank guarantee in instalments of Rs. 10 lakhs each in the form in Annexure-6 issued by a Vadodara branch of any Scheduled Indian bank or by a foreign exchange.” (underlined by us)
13. The assessee obtained tender documents prepared by the Nigam in December, 1998 for the work of constructing Narmada Main Canal in the reach of Kms. 108 to 144 on 3rd January, 1989. A corrigendum dated 1st May, 1989 of the above tender document was obtained on 1-6-1989 and the assessee submitted their offer of the above work on 15th July, 1989. Acceptance of the bank offer was conveyed to the assessee by the Nigam on 27th December, 1989 and the assessee furnished initial security in the form of bank guarantee on 29th January, 1990 of Rs. 2,56,63,000/- and renewed the same from time to time upto 30th April, 1999 after an interval of 6 months.
14. From the details of the receipts during the year were Rs. 21,37,45,976/- we noticed that the tax of Rs. 47,71,311 was deducted at source based on the gross amount and a sum of Rs. 1,49,02,778 was deducted as security deposit from the running bills. Out of the said amount, the assessee encashed and received a sum of Rs. 140 lakhs by furnishing bank guarantee in previous year under consideration.
15. On a careful reading of the aforesaid terms and conditions of the tender and the general conditions governing the contract for construction of Sardar Sarovar Main Canal, it is evident that the assessee was to make an earnest money deposit along with tender; that the said earnest money was to be refunded on successful bidding and was to be replaced within 30 days by a security deposit for performance; that the said security deposit was to be of Rs. 2,56,63,000/- and was made by way of furnishing a bank guarantee and renewed from time to time within an intervel of 6 months; that besides the aforesaid initial deposit the assessee was required to give additional security upto 5% of the tender amount which was to be deducted from the running bills at the rate of 10% of billed amount until it reached the said 5% of the tender amount; that for the year 1992-93 it worked out to Rs. 1,49,02,778/- and was encashed to the extent of Rs. 1,40,00,000/- by furnishing the bank guarantee; that the initial security deposit and the addition security deposit were to be in the form of bank guarantee or performance bond in the former case and in the form of deduction from running bills or at the request of the assessee, as an interest- bearing government/SSNNL security or interest-bearing bank deposit or a bank guarantee in instalments of Rs. 10 lakhs each in the letter case; and that the assessee opted for the bank guarantee form of additional security deposit and received the said money deducted from running bills by furnishing bank guarantee. It is thus nothing but a security deposit; and not a retention money which could be said to have not accrued to the assessee. In our opinion, it accrued to the assessee and thereafter retained by way of additional security and in fact received by the assessee by furnishing a bank guarantee.
16. There is no dispute about the proposition that the income accrues only when there is a right to receive i.e. there must be a debt owed to him by somebody-the “debitum in presenti solvendum in futruo” (E.D. Sassoon) and the scope of the term ‘accrue’ or ‘arise’ cannot be extended so as to take the amount received in a year unless a right to receive is there. Nor does the entry in the books make the receipt as income if that was not an income in the eye of law, though as per provisions of Section 145 income of an assessee is to be computed as per the system of accounting it followed which in this case admittedly is mercantile i.e. on accrual basis (Kedarnath Jute, Gujarat Mineral, Core Healthcare, Anup Engineering, Western India).
17. In Hindustan Housing and Land Development Trust Ltd.(supra) the arbitration award was the basis of accrual and that itself was challenged and, therefore, no income was held to have accrued and in that context, the question was answered that the mere receipt by furnishing security did not make the receipt as income
18. Shoorji’s case(supra) was a case where income did not result at all due to change in the agreement and it was found to be in the nature of hypothetical income which did not result at all nor materialised.
19. In the case of Godhra Electricity Co.Ltd. (supra) the enhanced rate of electricity was credited in books of accounts but on account of litigation about the rates and pendency of suits followed by the letter of Under Secretary to Government of Gujarat and the taking over of the company by the government, the enhanced charged but not recovered at all and in this context it was held that no income resulted at all and the receipt was only a hypothetical income which really never accrued to the assessee.
20. In Bokaro Steel’s case (supra), the original agreement ceased to be operative initio and the entries regarding income of interest shown by the assessee were reversed in the next year since the supplier had replaced 8 locomotives lent by the assessee company to it by new ones. The entire nature of transaction was changed between the parties. There was a resolution of the assessee company in this regard and the income from interest did not result at all as the original agreement ceased to be operative ab initio. The entry in the books which was made was about a hypothetical income which did not materialise and the entry was reversed in the next year.
21. In all there cases, the Supreme Court held that there was no real income and, therefore, not exigible to income-tax; whereas in the present case, it is nobody’s case that no income has resulted at all. The question is only as to in which year it accrued to the assessee. According to the Revenue, it was in the year when the bills were presented and passed for payment and the assessee received the money by furnishing bank guarantee and as per the assessee it was the year after the performance liability clause was over and the bank guarantee were released and ceased to be operative.
22. Gajpal Naidu’s case was a case of a receipt in later year which was not a basis of right accured in the earlier year. The assessee in that case supplied bread to a government hospital under a contract during the period April 1, 1948 to March 31, 1949, made certain representation to the government after the close of the year that he had incurred losses. The government directed the payment of the sum of Rs. 12,447/- to the assessee by way of a compensation for the loss sustained in respect of the supply of the bread. That amount was received by the assessee in a later accounting year 1950-51. In these circumstances, it was held by the Supreme Court that the amount ought to be included in the profits of the year 1950-51 relevant to the assessment year 1951-52 and that it could not be related back to the earlier year during which the assessee actually supplied bread to the hospital. It was observed that no power is conferred on the Income-tax Officer under the Act to relate back an income that accrued or arose in a subsequent year to another earlier year on the ground that that income arose out of an earlier transaction. In the present case, the work was done by the assessee in the year under consideration. The bill was also raised by the assessee in the year under consideration. It was passed by the government in the year under consideration. The assessee received the money by furnishing a bank guarantee in terms of the contract in the year under consideration. Therefore, the right to receive accrued in the year under consideration itself.
23. These are the cases determining the general principles and no dispute can be raised with regard to their applicability. The direct decisions on the issue are Simplex Concrete Pipe (supra) of Calcutta High Court, Chanchani Brothers (supra) of Patna High Court and Janatha Contracts Co. (supra) of Kerala High Court and few Tribunal decisions.
24. In Simples case, no right was held to have accrued for 10% or 5% which was retained but realised on completion of the work when the assessee fulfilled the obligation under the contract. It was a case of deduction as retention money to be paid on fulfilling the assessee’s obligation and not retaining the same as security for ensuring the successful completion of the project.
25. In Chanchani’s case (supra), the government did not accept bills presented by the assessee and in this context it was held that the income accrued when the bills were accepted and work done beyond contract. In Janatha’s case (supra) the contention was that the retention money shall not be released before the expiry of 3/6 months or issue of certificate of completion or when the final bill has been prepared whichever is later. It was thus a case of interim bill where the retention money was withheld 0whereas in assessee’s case each part of the work was final in itself.
26. In Apollo’s case supply of Hot Mix Plant supplied was to be installed by the assessee. 90% of the payment was to be made on proof of inspection and despatch and balance 10% was to be paid after the receipt in store in good condition and final inspection as per Clause 17(a) which was done after the close of the year. The Tribunal had noted the condition of erection and commissioning by the assessee and it was held to be a case covered by the decision of Calcutta High Court in the case of Simplex Concrete Pipe (supra).
27. In Kevin’s case, the assessee was engaged in manufacture of Mark transformer equipments used in mega plants of fertilizers, petroleum, etc. The contract contained a retention clause of 10% / 5% throughout guarantee period of 12 to 24 months. The assessee had been making provision for warrantee from year to year reversing the some on the expiry of the guarantee period based on the performance bank guarantee. It was a case of provision made for liability. The Tribunal held that as per the standard of the Institute of Chartered Accountants Clause 9, the income to the extent of bank guarantee did not accrue.
28. The Tribunal also distinguished the case of Associated Cables (P) Ltd. 48 ITD 141(TM) wherein it has been held that sales proceeds released on bank guarantee was liable to be included in income as accrued receipt and only a discounted value of receipt which was subject to risk of loss if any defect should be adopted, was distinguished by stating that “It is relevant to add here that in Associated Cables, case not a single instance has been cited by the assessee in which 10% of the sale value covered by the bank guarantee has not been paid to the assessee. The assessee in that case did not furnish any instance of encashment of bank guarantee. Thus even on facts the decision is clearly distinguishable from the facts of the present case.” It further observed that “The receipt of bank guarantee or withholding by the payee in the opinion of the Tribunal did not make any difference as the control and ownership of the amount vest with the customer and the amount can be recovered by the customer at any time by unilateral encashment of bank guarantee without any reference to the assessee and without pointing out any default on the part of the assessee in the matter of quality and performance of the goods supplied under the contract. Thus, mere payment against furnishing of bank guarantee is of no consequence whatsoever except that it may enhance the liquidity of the assessee. The decision of Hon’ble Supreme Court in the case of CIT v. Hindustan Housing and Land Development Trust (161 ITR 524) supports the view taken by us.”
29. We may refer at this stage the decision of the Tribunal in the case of Dhorajia Construction Co. ITA Nos. 4327 and 4665/Ahd/1996 order dated 29-08-2002 wherein the Tribunal held that the 10% deduction was retained as security deposit and therefore could be said to have not accrued to the assessee. In that case, the receipt was subject to tax deduction at source and retention as security deposit of 10% of the value of the contract subject to a maximum of Rs. 10 lakhs. This retained money as security deposit was refunded to the assessee only on the basis of the receipt and after a certificate of satisfactory completion of the work and the defect liability period of 6 to 12 months was over. The assessee claimed that until the certificate of satisfactory completion of the work, the retained amount as security deposit did not accrue to the assessee. The Tribunal held that the deduction of 10% of the contract value subject to a maximum of Rs. 10 lakhs was a security deposit and the mode of payment was by deducting from running bills as prescribed under the agreement and that it was an income accrued to the assessee. The relevant observations of the Tribunal are as under:-
“Security Deposit is thus 1% of the contract value subject to a maximum Rs. 10 lakhs. It is to be deposited by the assessee. The mode of the payment is by deduction from running bills. This is only one of the modes prescribed thereunder. As per the terms of the agreement it may be deposited by the assessee in cash or in the form of Government Securities. It is not retention money which might accrue only on certification of satisfactory completion. We may examine the issue from a different angle, suppose the assessee opted to deposit cash as security deposit instead pf by deduction from the running bills, could it be called a retention money? The entire billed amount, in our opinion, accrued to the assessee and the deduction of 10% was only to fulfill the obligation of the assessee for making the security deposit. It was an application of income. The case law relied upon by the assessee namely Calcutta High Court decision in the case of CIT v. Simplex Concrete Piles (India) Pvt. Ltd. 179 ITR 8 is a case of retention of money and not security deposit. The contention of the AO that retention was a security deposit was not accepted by the High Court when it observed, “certainly, therefore, there is no warrant for the Income-tax Officer’s order that the entire payment becomes due immediately, but 5 or 10% is withheld as security…….From the facts as we have already set out hereinbefore, we do not find any reason to hold that the entire amount became due immediately upon the submission of bills but that 5 or 10 percent of the bills, as the case may be, was withheld as security……” On a reading of the Calcutta High Court decision aforesaid, we find that the amount was not to be deposited by the assessee as a security deposit, but it was retained as a retention money to be paid only on certification of the satisfactory completion of the work. It is deducted from the running bills whereas in the present case as aforesaid, the amount was to be deposited by the assessee as a security deposit not necessarily by deduction from the running bills but even from its own sources, either in cash or in the shape of government securities. The assessee is also entitled to interest on a portion of the money which is deposited by way of government securities. This, in our opinion, clearly shows that the entire money belonged to the assessee and the 10% amount withheld was only as a security and not a retention money. Withholding of the money from the running bills and making of deposit for due fulfilment of the contract are two different concepts. In the former case, the right to money accrued only on satisfactory completion of the work whereas in the latter case, the amount had already accrued to the assessee and the deposit was made as an application thereof. It is stated by the learned counsel for the assessee that the amount has been assessed in the subsequent year on receipt basis and therefore, if the amount is added again here, it would amount to double taxation. It might be true, but the assessment is on the true income of the assessee for the year under consideration and if any part thereof has been offered or assessed in the subsequent year, that would not be in accordance with law and the assessee would be entitled to seek necessary relief from the appropriate authority. Subject to these remarks, we reverse the order of the CIT (Appeals) and restore that of the AO on this issue.”
30. Retention money in this case also is against satisfactory performance which in fact was released to the assessee on furnishing of bank guarantee. The assessee opted for furnishing bank guarantee instead of allowing it to remain as withheld money. Furthermore, like in that case of Dhorajia Construction the tax has been deducted at source on the full amount without deduction of the said retention money of 10%. This also is an indication that the entire receipt has accrued to the assessee and its obligation for due performance are assured by furnishing the bank guarantee. The liability under the contract is for assuring the customers of due performance and obligation of the assessee and not to retain the money so that it does not accrue to the assessee. Income accrued to the assessee the moment the work is done and the bill is raised which has been done by the assessee in this year. Bills have been passed and the payments made to the assessee. Liability may arise in future and for inefficient performance and in this case it did not happen at all.
31. The case of the assessee, in our opinion, is also closer to the facts of Third Member decision of the Tribunal in the case of Associated Cable (P) Ltd.(supra). In that case the assessee company was engaged in manufacturing of instrumentation cable being of highly sophisticated and costly one as per the specification provided by the client. As per the terms of the supply, the assessee billed 90% of the value of the goods manufactured on dispatch and delivery with the exception that on 100% of the cable cost was payable to the assessee only on completion of the warrantee period. The assessee contended that the said 10% did not represent the sale as its receipt was conditional based only on fulfilment of certain conditions, namely, receipt and acceptance of goods at purchasers site; submission of all final technical documentation as required; and submission of performance and workmanship bank guarantee, valid for the guarantee period, for an equivalent amount issued by the Scheduled Bank. The said guarantee period was 12 months to 3 years. The terms of payment as stated in Clause 36 of the agreement provided as under:-
“For supply and delivery order 90% of the order price of goods dispatched within 30 days of presentation of dispatch documents including Material Acceptance Certificate of Inspection Release Note 10% of the order price of goods dispatched within 30 days of receipt of goods at destination subject to inspection and acceptance and receipt of a Satisfactory Bank Guarantee for equal amount valid till the expiry of the guarantee period of the equipment materials and as per specimen attached (proforma 2).”
32. The Judicial Member held that under the terms of the contract the assessee had right to receive the amount and, therefore, it could not be excluded in computing the total income whereas the Accountant Member held that until the guarantee period was over the assessee had no right to 10% of the amount and hence it should be excluded from the total income. The Third Member agreed with the Judicial Member in saying that under the terms of the contract, the assessee had a right to receive the balance 10% on furnishing bank guarantee. He, however, also agreed with the Accountant Member that because of the bank guarantee the assessee did not have an unconditional right to appropriate the said sum even though it could receive the amount and in that connection, the Third Member referred to the Accounting Standard of the Institute of Chartered Accountants referred to above and observed that-
“In the present case even though the assessee had received the balance of 10%, the bank guarantee for performance clearly shows that the receipt was at the risk of losing the amount if there was any defect in the good. It would appear that this situation was a contingency and it is possible to view this as a contingent expenditure. But as held by the Supreme Court in the case of Metal Box Co. of India Ltd. v. Their Workmen [1969] 73 ITR 53, contingent liabilities discounted and valued as necessary can be taken into account as trading expenses if they are sufficiently certain to be capable of valuation and if profits cannot be properly estimated without taking them into account. In my option that would probably be the correct method, viz., to take into account 100% of the price and provide as against that an estimated amount as a provision for performance guarantee.”
33. In the present case also, in our opinion, the assessee had a right to receive the entire amount and in fact received the same on furnishing the bank guarantee and it could at best be a case for incurring a liability that may arise due to the defect clause of the performance for which the security was taken by deducting a certain amount from the running bills. In paragraph 16 of the order of Tribunal in Apollo’s case (supra) it is also stated as under to the similar effect:-
“16. Even if the assessee is to account for the entire sale value including the 10% if the sale value covered by the bank guarantee, the liabilities arising from the warranties and guarantee, the liabilities arising from the warranties and guarantee as well as the uncertainties involving the possible encashment of bank guarantee by the customer have to be taken care of for the purpose of presenting a true and fair view of financial results of the enterprise. Looked at from this angle, Accounting Standard 4 issued by the institute of Chartered Accountants of India would be relevant. Para 10 of the Accounting Standard 4 deals with the contingencies and reads as under:-
“The amount of a contingent loss should be provided for by charge in the statement of profit and loss if; (a) it is probable that future events will confirm that after taking into account any realated probable recovery an asset has been impaired or a liability has been incurred as at the balance sheet date and (b) a reasonable estimate of the amount of the resulting loss can be made.”
Para-7.3 of the Accounting Standard clearly provides that uncertainties creating a contingency may relate to the warranties for products sold. These costs are usually incurred frequently and experience provide a means by which the amount of liability or loss can be estimated with the reasonable precision and the same can be provided for in the financial statements prepared by the enterprise. Now in the instant case the claim of the assessee; that warrantee provision is revenue deductible is clearly in conformity with the Accounting Standard 4 and therefore deserves to be accepted.”
34. Clauses 10 and 11 of Accounting Standard (9) referred to in the case of Associated Cables and Kevin’s case (supra) are as under:-
“10. Revenue from sales or service transactions should be recognised when the requirement as to performance set out in para-11 unreasonable to expect ultimate collection. If at the time of raising of any claim it is unreasonable to expect ultimate collection, revenue recognition should be postponed.
“11. In a transaction involving the sale of goods performance should be regarded as being achieved when the following conditions have been fulfilled.
(i) The seller of goods has transferred to the buyer the property in the goods for a price or all significant risks and rewards of ownership have been transferred to the buyer and the seller retains no effective control of the goods transferred to the degree usually associated with ownership and
(ii) No significant uncertainty exists regarding the amount of the consideration that will be derived from the sale of the goods.”
35. We may also refer to certain paragraphs of the revised Accounting Standard 7 (Revised 2002) deal with ‘Recognition of Contract Revenue and Expenses’.
“21. When the outcome of a construction contract can be estimated reliably, contract revenue and contract costs associated with the construction contract should be recognised as revenue and expenses respectively by reference to the stage of completion of the contract activity at the reporting date. An expected loss on the construction contract should be recognised as an expense immediately in accordance with paragraph 35.”
22. In the case of a fixed price contract, the outcome of a construction contract can be estimated reliably when all the following conditions are satisfied:
(a) total contract revenue can be measured reliably;
(b) it is probable that the economic benefits associated with the contract will follow to the enterprise;
(c) both the contract costs to complete the contract and the stage of contract completion at the reporting date can be measured reliably;
(d) the contract costs attributable to the contract can be clearly identified and measured reliably so that actual contract costs incurred can be compared with prior estimates.
24. The recognition of revenue and expenses by reference to the stage of completion of a contract is often referred to as the percentage of completion method. Under this method, contract revenue is matched with the contract costs incurred in reaching the stage of completion, resulting in the reporting of revenue, expenses and profit which can be attributed to the proportion of work completed. This method provides useful information on the extent of contract activity and performance during a period.
25. Under the percentage of completion method, contract revenue is recognised as revenue in the statement of profit and loss in the accounting periods in which the work is performed. Contract costs are usually recognised as an expense in the statement of profit and loss in the accounting periods in which the work to which they relate is performed. However, any expected excess of total contract revenue for the contract is recognised as an expense immediately in accordance with paragraph 35.
27. When an uncertainty arises about the collectability of an amount already included in contract revenue, and already recognised in the statement of profit and loss, the uncollectable amount or the amount in respect of which recovery has ceased to be probable is recognised as an expense rather than as an adjustment of the amount of contract revenue.
31. When the outcome of a construction contract cannot be estimated reliably:
(a)revenue should be recognised only to the extent of contract costs incurred of which recovery is probable; and
(b) contract costs should be recognised as an expense in the period in which they are incurred.
An expected loss on the construction contract should be recognised as an expense immediately in accordance with paragraph 35.
32. During the early stages of a contract it is often the case that the outcome of the contract cannot be estimated reliably. Nevertheless, it may be probable that the enterprise will recover the contract costs incurred. Therefore, contract revenue is recognised only to the extent of costs incurred that ate expected to be recovered. As the outcome of the contract cannot be estimated reliably, no profit is recognised. However, even though the outcome of the contact cannot be estimated reliably, it may be probable that total contract costs will exceed total contract revenue. In such cases, any expected excess of total contract costs over total contract revenue for the contract is recognised as an expense immediately in accordance with paragraph 35.”
36. From the above also, it is evident that entire billed amount was to be accounted as revenue and if any uncertainty is there in collection of a part thereof on account of certain contingencies, the estimate thereof can be claimed as an expenditure. No uncertainty has been pointed out in the present case and in fact, the assessee has been relieved of the bank guarantee in the year 1999-2000 without any liability on account of defect clause of the performance of it might be that such a liability was incurred and met by the assessee in subsequent years and claimed and allowed as an expenditure in future year for ineffecient performance and that has not been allowed as deduction in those years, an estimated liability can be allowed in this year and brought to tax in asst. year 2000-2001. For this limited issue, we set aside the order of the AO and direct him to consider the claim of the assessee if made.
37. The case may be examined from examined from a different angle as well. On the one hand, the assessee is debiting the entire expenditure in its profit and loss account but, on the other hand, it is recognizing the revenue only of the 90% of the billed amount of the work done. If the assessee’s claim is that the balance 10% of the amount has not accrued to it the expenditure to that extent would also not be relatable to the work completed or that 10% of the billed amount not shown as income and consequently, the expenditure cost is to be relatable to future completion of contract and, therefore, to be taken as work-in-progress. In other words, at best, the assessee could say that the profit portion embedded in the said 10% above may not be income of the assessee in the year under consideration and only that part of the amount could be excluded from its income. Therefore, even if it is held that the retention money had not accrued Therefore, even if it is held that the retention money had not accrued, normally the profit from construction business is 8% to 10% and at that rate only 1% of billed money at the highest could be postponed to AY 2000-2001 and not the entire retention money. However, since we have held that the entire billed amount has accrued to the assessee, we need not give any direction in this regard.
38. The facts and circumstances appearing in AY.1993-94 are stated to be similar with regard to addition of Rs. 36,68,397/- and for the reasons aforesaid, we reverse the order of the CIT(A) on this issue in both the years and restore those of the Assessing Officer – subject to out directions in paragraph 36 above. We also leave it open to the assessee to seek appropriate relief from the concerned authority for the assessment of those income offered in subsequent years if so advised and in accordance with law.
39. In the assessee’s appeals, the common dispute is against the disallowance of Rs. 48,013/- made out of travelling expenses. In the absence of details filed, the AO disallowed 10% of the expenses claimed by the assessee. The CIT(A) upheld the disallowance. The assessee’s claim is that the entire expenditure has been incurred for the purpose of business and in any case, the disallowance of 10% seems to be excessive. We are, therefore, of the opinion, that it would meet the ends of justice if the disallowance of 5% is made. The AO is, therefore, directed to reduce the disallowance to 5%.
40. The nest common dispute is against the disallowance Under Section 40A(3) of Rs. 2,07,047 and Rs. 1,57,196/- respectively in the two years under consideration. In the audit report, it is stated that the parties were new and did not accept the payment by cheque was not accepted as good reason by the AO as the payees were well-known and reputed concerns like Cummins Diesel Sales and Services (I) Ltd., Telco Jamshedpur, Premier Automobiles, Soni Enterprises, Aiutomatic Manufacturer Ltd. etc.
41. The CIT(A) upheld the disallowance by observing as under:-
“I have considered the facts and appellant’s submissions. It is relevant to note that the assessing officer has highlighted the fact that the appellant has not substantiated its claim of the so-called exceptional and unavoidable circumstances under which the said payments have been made in case. Considering the fact that the appellant has not substantiated its claim of the so-called exceptional and unavoidable circumstances under which the said payments are claimed to have been made in cash, it is held that the said cash payments are not covered by the provisions of Rule 6-DD(j) of the Income-tax Rules, 1962. Accordingly, the assessing officer’s action in making the addition under Section 40A(3) is held to be proper, and stands confirmed. Therefore, the addition of Rs. 2,07,047/- made under Section 40A(3) stands confirmed. Accordingly, the appellant’s appeal on this point stands dismissed.”
42. In asst. year 1993-94, the AO has given the details as under:-
1. Chamunda Scrap Trade Mart, A'bad. Rs. 11,580
2. Kedarnath Khandelwai Road Tax on his
behalf. Rs. 14,408
3. Prakash Steel Corporation Rs. 14,300
4. Shree Krishna Cement, Savalia Rs. 22,000
5. Nathalal P. Shah, Savalia Rs. 25,000
6. Shree Diesel Pump Services Rs. 25,000
7. The Panchmahal District Co-op. Milk
Products Union Ltd. Rs. 11,840
8. -do- Rs. 10,880
9. -do- Rs. 11,760
10. Ghanshyam & Co., Bombay Rs. 18,120
11. The Panchmahal District Co-op. Milk
Producers Union Ltd. Rs. 17,600
12. Manan Engineers, Ahmedabad Rs. 15,751
13. The Panchmahal District Co-op. Milk
Producers Union Ltd. Rs. 10,080
14 Pramukh Swami Hospital Debited to
Medical Expenses Rs. 10,040
15. Velani Chemicals - Debited to Malsaman Rs. 12,330
16. Cummins Diesel Sales & Services Ltd. Rs. 14,009
17. Chclo Transmission Ltd. Rs. 10,246
____________
Rs. 2,41,464
____________
43. The assessee has given a chart explaining the circumstances under which the payments were made in cash, the main reason for making the payment in cash being that neither the assessee not the payees were having bank accounts at the places where the payments were made and claimed that the same would be covered by the Board’s Circular No. 220 dated 31-5-1977. On these facts and circumstances of the case, we set aside the order of the CIT(A) as well as of the AO the remit the matter back to the file of AO to examine the claim of the assessee in the light of the reasons given in the chart and allow the claim of the assessee in accordance with law.
44. The nest disputes in the assessee’s appeal for asst. year 1992-93 against the disallowance of Rs. 75,000/- Under Section 40A(12) of the Act and in the appeal for asst. year 1993-94 against the disallowance of royalty payment of Rs. 2,68,903/- were not pressed and are, accordingly, rejected.
45. The nest common dispute in both the appeals of the assessee is against the disallowance of Rs. 50,000/- and Rs. 60,000/- respectively as entertainment expenditure. On going through the details of miscellaneous expenses, staff welfare expenses and office expenses, the AO found that many of these expenditure wee on proving tea, snacks, etc. and in absence of bifurcation, he estimated the same at Rs. 50,000/- and Rs. 60,000/- as entertainment in nature and disallowed the same Under Section 37(2A) of the Act. The CIT(A) upheld the disallowance by observing in paragraph 2.6 as under:-
“2(vi) Entertainment expenses
Vide the impugned assessment order the assessing officer has mentioned that some of the expenses claimed as miscellaneous, staff welfare and office expenses are in the nature of entertainment expenses. In the absence of proper details of the said expenses, the assessing officer has disallowed the sum of Rs. 50,000/- under Section 37(2A). The appellant has objected to the assessing officer’s action. It is the appellant’s contention that all the said expenses have been incurred wholly and exclusively for the appellant’s business and that the assessing officer has wrongly made the said disallowance.
I have considered the facts and appellant’s submissions. It is relevant to note that the assessing officer has made the said disallowance for want of proper details of miscellaneous, staff welfare and office expenses. Moreover, considering the totality of the facts discussed in the assessment order, the quantum of disallowance made by the assessing officer cannot be said to be excessive or unreasonable. Therefore, the addition of Rs. 50,000/- as entertainment expenses stands confirmed.”
46. Looking to the magnitude and nature of expenditure which was claimed by the assessee, we do not find any reason to interfere to interfere with the order of the CIT(A). The disallowance made by the AO cannot be said to be excessive even. The ground is, accordingly, rejected.
47. In the result, the appeals of the Revenue are allowed pro tanto whereas the appeal of the assessee is partly allowed.